The Weekly Wire: For Your Situational Awareness 7/16/20

 In Weekly Wire
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KF-X Financing Troubles

Aaron Lin, Research Associate

The COVID-19 pandemic has had a wide range of effects on defense programs and spending around the world. One of the biggest defense programs in Asia, the KF-X fighter development project, is feeling the effects of COVID-19 in the form of payment delays from Indonesia. This issue of payment delays began well before the onset of COVID-19, which has exacerbated the issue. Based on a 2015 agreement, Indonesia is responsible for 20 percent of the development costs of the future 4.5 generation fighter. 60 percent of the developments costs are covered by the South Korean government, and the remaining 20 percent by Korean Aerospace Industries (KAI). In April 2020, Korean defense minister Chung Kyung-Doo presided over an emergency meeting to discuss the costs of the program and how to cover them. But as of April 2020, Indonesia had fallen behind on payments to South Korea by about KRW 500.2 billion ($420 million). The COVID-19 pandemic has already placed strain on defense budgets in both countries, with South Korea reducing its 2020 defense budget by $1.06 billion (2.4 percent) and Indonesia its 2020 defense budget by $589 million (6.6 percent).

There has been speculation that Indonesia may exit the program altogether. Indonesia has been increasingly unsatisfied with the amount of technology transfer it has received for what it is paying. The weakening of the Indonesian rupiah relative to 2015 has made payments more difficult and expensive. An Indonesian exit from the program cannot be entirely ruled out as a possibility, there are several factors and consequences to consider that will dictate if this happen.

Indonesia’s priorities for the project were centered around technology transfer to build up its local defense industrial base. But questions surround how much Indonesia and PTDI will be able to obtain in the face of US export restrictions that are attached to some of the US-sourced subsystems on the aircraft. Even South Korea has had issues getting US approval for core technologies on the aircraft, particularly on the AESA radar, electronic warfare systems, infrared search and track (IRST), and electro-optical targeting. If Indonesia continues its part in the program, involvement may end up being concentrated in local production and some modifications for Indonesian requirements. The issue for the Indonesian government is whether this is enough of a technological and industrial benefit to warrant continued payment to stay a part of the KF-X program. Despite the stated need for a larger fighter fleet, Indonesia still places a higher priority on bolstering access to remote islands and maritime security. Recent incursions of Chinese fishing vessels escorted by China Coast Guard ships highlighted Indonesia’s continued maritime security gaps. Moreover, being able to supply remote islands has been a long-standing issue of territorial integrity and control for the archipelagic country.

South Korea does not yet appear to have a concrete plan for how to cover Indonesia’s share of development costs should they pull out. The current agreement is structured such that delays in payments from Indonesia and PTDI place a more significant burden on KAI. Losing Indonesian funding would force South Korea to figure out how to pay for Indonesia’s share, potentially delaying the development timeline. Furthermore, an Indonesian exit could also jeopardize Indonesian procurements of the aircraft. Should the Indonesian Air Force (TNI AU) cancel its plans to acquire 50 aircraft, it would mean unit cost increases for South Korean procurements and a significant loss for South Korean defense exports. South Korea will undoubtedly continue to pursue the project with or without Indonesia. The issue becomes what other projects South Korea may need to sacrifice to keep the KF-X program going.

Overall, South Korea’s larger defense budget and effective COVID-19 response means that it may have more budget flexibility to fund the entirety of the KF-X project, though it will still be very costly. Any costs that Indonesia can share would be helpful. Indonesia has a much more limited defense budget and is still a developing economy that has a wide range of economic priorities that must be funded, particularly as COVID-19 impacts its economy. Beyond the KF-X program, Indonesia and South Korea have already signed agreements to cooperate on the construction of three submarines for Indonesia. While the submarine agreement does not appear to have had the same degree of financing issues as the KF-X program, many of the underlying dynamics are similar. Indonesia hopes to improve its defense industrial base with the program but must contend with a more limited budget. South Korea may not have as much budget pressure, but risks losing income to support defense projects and losing some high-profile defense exports.

US

On Monday, the US Air Force announced multiple contracting awards and actions for the F-15EX, the F-15’s newest variant. This included not only the award of the overall contract, an indefinite delivery, indefinite quantity with a potential $22.8 billion cost ceiling, but also the placing the first $1.2 billion delivery order for the eight jets authorized in the FY2020 budget. The F-15EX will feature the EPAWSS electronic warfare upgrade originally slated for the F-15C fleet (and currently being rolled out to the F-15E fleet), as well as the Advanced Display Core Processor enabling an Open Mission Systems architecture. Moreover, the two-seat F-15EX will feature a seemingly basic, but critical, upgrade over the aging F-15C/D fleet: fly-by-wire controls. The first two test aircraft are slated to be delivered to Eglin Air Force Base in mid-2021, with the remainder of the first batch of aircraft set to arrive in 2023. While the F-15EX has been budgeted and marketed as a 144-aircraft campaign to replace the aging F-15C/Ds in the Air National Guard, the structure of the IDIQ allows for up to 200 F-15EXs to be acquired under the presumed $87.7 million flyaway cost.

France

As part of the Military Programming Law 2019-2025, France is looking at replacing its three E-2C Hawkeye aircraft operated by the French Naval Aviation. The US State Department approved the sale, under the Foreign Military Sales channel of three E-2D Advanced Hawkeye aircraft and equipment manufactured by Northrop Grumman. The sale also includes 10 Rolls Royce T-56-427A engines and three AN/APY-9 radar produced by Lockheed Martin. The overall deal value could reach $2.0 billion.

Philippines

On July 13, the Philippine Navy decided to push back an intended purchase of two new corvettes. The Philippines has structured its military modernization efforts in three waves – which are referred to as Horizons. Originally, the Philippines included the corvette as part of the Second Horizon, which began in 2018 and will end in 2022. The first horizon lasted from 2013-2017 and saw the purchase of an array of platforms, including two new naval cutters, two C-130s, and 12 FA-50 fighters. The Second Horizon was intended to be similar, but the coronavirus pandemic has placed unanticipated pressure on the economy of the Philippines. As a result, the $600 million corvette purchase has been delayed until the Third Horizon, which will last from 2023-2028. Currently, it is unclear how many other procurements from the Second Horizon will be similarly delayed.

Lebanon

Last week, the Lebanese government detailed plans to sell five obsolete Hawker Hunter fighter jets and three Sikorsky S-61 helicopters to reallocate Air Force resources. The fighters have been nonoperational since 1990, while the helicopters have proven increasingly costly to maintain. This effort can best be understood within the context a broader Air Force revitalization program that has included recent procurements of six Super Tucano equipped with Advanced Precision Kill Weapons Systems, an armed Cessna equipped with Hellfire missiles, and Huey II helicopters. The Air Force is also expecting a delivery of six MD-530G helicopters early next year and is currently negotiating with Pakistan to procure primary training aircraft. The move also appears sensible considering Lebanon’s ballooning economic crisis, which has cast doubt on near-term military spending initiatives. Lebanese officials are yet to identify prospective buyers of the Hawker Hunters or the Sikorsky S-61s, though both platforms are thought to be suitable for private sector use. Lebanese leaders have affirmed that any potential transaction would align with U.S. national security interests, as the operational capacity of the nation’s armed forces relies heavily on foreign military financing.

New Zealand

The government of New Zealand has ordered 43 Bushmaster 4×4 combat vehicles from Thales Australia for NZD $102.9 million ($67 million). The contract includes the production of the vehicle in five different configurations (troop carrier, command, patrol, support, weapons deployment and ambulance), but also training services, simulators devices (to be installed in Linton Army Base) and vehicle operational support. Deliveries are expected to occur by 2022 as the Army is hoping to reach its operational capability in late 2023.

The Bushmaster is an 11-ton armored vehicle, with a passenger capacity of 10 people and has a four-ton payload. New Zealand armed forces are already familiar with the Bushmaster since Special Forces are operating a dozen of them as “Special Operations Vehicle- Protected Heavy.” The 43 new units will partially replace a portion of the 321 Pinzgauer from Steyr-Daimler-Puch that were acquired in 2004 and phased out in early 2014 due to higher attritions rates and mishaps.

The Bushmaster acquisition is part of the New Zealand’s recent strategy to modernize its armed forces capabilities by 2030, with a total dedicated budget of NZD $2 billion ($1.3 billion). Future opportunities include replacing the Pinzgauer and Unimog vehicles before 2024, and the 8×8 LAV-III modernization from 2026 at an estimated NZD $600 million ($394 million).

UK

On July 15, the UK announced that it had awarded a GBP 65 million ($80 million) contract to General Atomics for the first three Protector Remotely Piloted Air Vehicles to be manufactured for the Royal Air Force (RAF). The first aircraft, which will replace the RAF’s MQ-9 Reaper systems, will be delivered in 2021 although it will remain in the US for testing and evaluation before transferring to the UK in 2023. The actual in-service date of the system is 2024. The UK’s Protector RPAS will be able to launch Brimstone missiles as well as Paveway IV, while the current Reaper platforms utilize Paveway IV and the larger Hellfire missile. The contract includes an option worth GBP180 million ($230 million) for an additional 13 platforms, which would take the total number to 16. A decision on the contract options is expected in April 2021. The procurement of 16 platforms would provide double the capability currently provided by the RAF’s Reaper force, however this falls short of the 20 units originally planned. It is likely that the number of units being procured has been reduced due to financial constraints. The same financial constraints have seen delivery of the program slip with the Protector originally due to enter service in 2018.

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